Should I go for student loan forgiveness or not?
Not too long ago, student loan debt was like any other debt. You borrowed “x” amount, and you were expected to pay that loan back in full, plus interest.
Enter the forgiveness option. With forgiveness, the expectation is that you will NOT be paying your loans back in full. Whatever is left at the end of the loan term is forgiven.
This completely changes the game when it comes to paying back your student loans. Paying back your loans now requires a solid strategy that increases the odds that you will be paying back the least amount possible. But coming up with a game plan is proving to be quite the challenge.
WHY IS THIS EVEN AN OPTION?
As many of you are aware, higher education costs continue to far outpace inflation. It has gotten to the point where the amount of debt that students are graduating with is disproportionately high compared to their income. This is especially true for veterinary graduates.
As a result, the federal government decided to offer income driven repayment (IDR) plans for eligible federal loans (private student loans are treated completely separately and are not eligible for forgiveness). I wrote a brief overview of various plans in this post, but essentially, the amount that you’re expected to pay monthly is dependent on your income, not your loan amount.
Here are the four different income driven repayment plans:
- IBR (Income Based Repayment)
- ICR (Income Contingent Repayment)
- PAYE (Pay As You Earn)
- RePAYE (Revised Pay As You Earn)
For the purposes of this post, I will refer to these individual plans as simply the IDR plans. The takeaway is that they base your payments on your income, which will be capped at anywhere from 10-20% of your discretionary income. The loan terms are 20-25 years, and the forgiven amounts are taxable.
**Public Service Loan Forgiveness (PSLF) is a program where you can have your loans forgiven in as little as 10 years, and the amount forgiven is tax-free. You can read more about PSLF here. The rest of this post will focus on pursuing forgiveness plans through the IDR plans with no plans to apply for the PSLF program.**
**For information about forgiveness programs outside of using the IDR plans and PSLF, check out this page from the AVMA.**
FORGIVENESS SOUNDS GREAT! I’M ALL IN!
On the surface, having your loans forgiven seems like a GREAT plan. The thought of not having to repay your loans in full when you have six figure loans makes your loan burden seem less daunting. However, as with pretty much anything in life, there’s a catch (or two).
Here are some reasons that people are hesitant to go this route:
- The forgiveness option is relatively new, so we have yet to see any borrowers that have actually had their loans forgiven. Obviously, this gives people pause because it requires that you simply trust that your loans will eventually be forgiven when the time comes.
- Your loans are forgiven, but you are fully expected to pay taxes on that forgiven amount. As a quick example, say you have $100,000 forgiven at the end of your term. If you’re in the 30% tax bracket, you are expected to pay $30,000 in taxes. If you haven’t been saving for this tax bomb, then you can imagine the financial burden of coming up with $30,000 at tax time.
- It isn’t certain if forgiveness makes mathematical sense. You’re making a number of assumptions when you calculate your numbers. Our personal and financial lives can change a lot during a typical loan term (20-25 years). It is impossible to accurately project out future earnings, tax rates, and whether this program will continue to exist in its present form.
With all of this uncertainty, I can understand why some people aren’t exactly thrilled with going the forgiveness route.
CONSEQUENCES OF FORGIVENESS
Personally, I don’t think the government is going to go back on its word and take the forgiveness option away for borrowers that are currently working towards forgiveness. At the very least, as long as you’ve been filling out the proper paperwork for eventual forgiveness, they would need to honor that and grant forgiveness, even if the rules change in the future.
What I’m more concerned are the general financial choices that people make when they rely on forgiveness.
If you promise students that they can have their loans forgiven, what’s stopping them from maxing out their loans? Loans are already Monopoly money to many students. Student loans are ridiculously easy to secure, much more so than a mortgage. In many cases, these loan amounts are approaching or exceeding mortgages!
Maxing out your loans leads to a bigger tax bomb in the end. This means you have to set aside even more money for taxes, which then results in less cash flow for you.
Also, the major incentive to go for forgiveness is to lower your monthly payments. What tends to happen when you find more money in your bank account? Even if you have the best of intentions to be REALLY good with your money, you may find yourself inadvertently spending it, rather than saving and investing that money to build wealth. Lifestyle inflation is real.
However, there is no doubt that this option allows for more cash flow so that you can better live the life that you’ve always envisioned.
A GENERAL RULE OF THUMB
Your debt-to-income (DTI) ratio will be a big determinant of whether you should pursue a forgiveness plan. This simple ratio takes your student debt at graduation and divides it by your income. Here are some rough guidelines to determine whether you should pursue forgiveness:
DTI <1: Use the standard repayment plan to pay off your loans instead of going for forgiveness, because the math is working in your favor to pay the loans off more quickly. In this case, you can think of your loans in a more traditional sense because you will be paying them off in full.
DTI 1-2: This is considered the gray zone. You can read about it more in depth in this post. Basically, you can go either way (pay off in full or go for forgiveness), and much of this will depend on a number of factors that are unique to your situation. You can have 2 veterinarians with the same amount of debt and the same income, but these other factors will play a large role in how they will handle their debt. Personally, I advocate for paying down your loans if you have the means to do so, rather than stretching them out for the next 20-25 years.
DTI>2: This is when forgiveness may truly be your only option. Due to relatively high interest rates, it can be very difficult to pay down your loans in full when you have this debt burden. You may be a master at paying off your debt, but you may not be mastering other parts of your financial health, such as having an emergency fund, saving for retirement, becoming a homeowner, or owning a business. However, there are still people who are incredibly debt averse that would rather to pay off their loans than go for forgiveness. Check out this post highlighting a dentist who is in the middle of paying off nearly $600k of student loan debt.
Interested in playing around with your numbers? Check out this great calculator by the VIN Foundation.
GOING BEYOND THE DEBT-TO-INCOME RATIOS
Using the ratio guidelines is just the first step. Here are other factors you need to consider when making your decision:
- Income: When you are running your numbers, you are going to have to project out your future income. Of course, there is no surefire way to predict what your income will be in the future. If you stay as an associate, you can expect modest increases to your salary. If you’re a practice owner, you could significantly increase your earnings. Getting married adds a completely new component to the equation: you could marry someone who is equally (or more!) indebted with little income potential, or you could marry someone with no debt that makes a very high income. This can drastically change your strategy.
- Expenses: Being on an IDR plan certainly gives you more flexibility since it allows you to have more cash flow. Those that plan on having their loans forgiven have to be especially vigilant about saving in order to pay for their tax bomb. Don’t forget about all of the other ways you can use this “extra” money to create financial security and wealth.
- Term length: As I outlined in this post, I was perfectly fine treating my loan repayments like a mortgage when I was a fresh graduate. However, it got pretty old after about 5 years, which was when the longevity of these loan terms really started to sink in (you’re telling me that I have 25 years left of these payments??). If you go for forgiveness, you must be mentally prepared to ride it out for 20-25 years. Your balance may very well be going up as time goes on, which can be a frustrating feeling when you keep making those monthly payments and they’re not even touching the principal. You have to trust your numbers and trust your payback strategy.
There are so many shades of gray when it comes to student loan debt repayment. I am an advocate for paying off the loans in full if the math works in your favor. I am also aware that for many people, the math simply doesn’t work, and thankfully, these forgiveness plans exist for the sole purpose of helping these borrowers out. They could potentially save borrowers hundreds of thousands of dollars by getting their loans forgiven, so this is a decision that shouldn’t be taken lightly.
A borrower should seriously consider federal student loan forgiveness if:
- they have already explored and decided against other forgiveness options available to veterinarians, including PSLF
- they have a debt to income ratio greater than 2:1.
- they are fairly certain that their household income will not significantly increase in the near future (which would then decrease the household debt-to-income ratio and potentially change your payback strategy).
- they understand that they must start saving for their tax bomb ASAP.
- they are comfortable with the idea of carrying student loan debt for 20-25 years.
- they have faith that forgiveness WILL happen in the future.
As for the exact strategy on how to pay the least amount of student loans, consider the resources that I mention in this student loan repayment advice post. Again, this is a big decision, and there are resources out there that can help you make the best choice for your personal situation.
Have you decided to go for the forgiveness option? Was the decision easy or difficult? Do you have any other considerations to think about when going for forgiveness? Comment below!